An Environmental Scan of Pay for Performance in the Hospital Setting: Final Report. Theoretical Literature and Implications for P4P Design


P4P is common in industries other than health care, and economists and management experts have studied and developed theories on how individuals respond to financial incentives.  The economic and management theories that we reviewed suggest that the way in which P4P incentives are structured, or framed, could influence whether they achieve the desired behavioral response.  Among the key highlights of this literature review:

  • Withholds May Have More of an Impact Than Bonuses (Prospect Theory, Principle of Loss Aversion)—Individuals are more sensitive to incentives when they perceive they are losing as opposed to gaining something. The difference in the behavioral response for a choice framed as a loss rather than as a gain can be significant, almost twofold in magnitude (Kahneman and Tversky, 1979). P4P incentive payments can be structured as a withhold (a perceived loss in income) or as a bonus (a perceived gain). The theory of loss aversion suggests that if the goal is to drive hospitals to make changes that improve quality or efficiency, withholding dollars with the likelihood of later releasing them based on performance (i.e., framing the incentive as a possible loss) may lead to a greater behavioral response than framing the incentive as a “gain,” in the form of a bonus, even if the same amount of money is at risk.
  • A Series of Small Incentives Might Lead to More Quality Improvement Than Would One Large Incentive (Principle of Diminishing Marginal Utility)—The perceived value of a sum of money becomes progressively lower when associated with an increasingly larger sum of money.  People tend to judge such gains or losses as changes from their current state of well-being (or reference point), rather than their final states (Kahneman and Tversky, 1979). Thus, it may be more psychologically motivating to provide smaller, more-frequent incentive payments to providers than to provide a larger, lump-sum incentive payment. 
  • Uncertainty May Reduce the Behavioral Response (Principle of Risk Aversion)—Most people are risk averse; and when given a choice they will choose an option with 100 percent certainty over an option involving an uncertain but likely more valuable outcome. This principle suggests that decreasing the risk or uncertainty in the likelihood of receiving a financial incentive is likely to lead to a greater behavioral response to the incentive. Relative thresholds based on provider rankings, found in many P4P program designs, create greater uncertainty for hospitals than do payment schemes that use absolute thresholds (i.e., a fixed target) for determining who receives an incentive payment.  This is because the level of performance necessary to earn the incentive is unknown until after the performance period has ended.
  • Reducing the Time Lags Between Performance and Receipt of Incentive Can Help to Achieve Maximum Response (Principle of Hyperbolic Discounting)—Individuals value having a sum of money now more than sometime in the future, even after accounting for inflation. Instead of discounting in a linear fashion, the individuals tend to discount at a steeper, hyperbolic curve. In the context of P4P program design, minimizing the lag time between the performance being incentivized and receipt of the incentive may strengthen the behavioral response. Substantial time lags between data collection and payouts may cause a hospital to see the incentive as occurring so far in the future that it is not worth pursuing. 
  • A Series of Tiered Absolute Thresholds May Be Better Than One Absolute Threshold (Goal Gradient)—An individual’s motivation and effort when faced with a goal greatly depends on that individual’s baseline performance.  If baseline performance is far away from goal performance, the individual exerts little effort, because the goal is viewed as not immediately attainable. As baseline performance gets closer and closer to goal performance, the individual exerts more and more effort to succeed. However, as soon as the goal is achieved, the motivation to improve decreases significantly.  Applied to P4P, this principle implies that there would be a greater behavioral response among hospitals if there were a series of quality performance thresholds to meet (e.g., increasing dollar amounts for achieving a 50 percent, a 60 percent, a 70 percent, an 80 percent, and a 90 percent performance threshold) rather than one (e.g., a 75 percent performance threshold). Another way to structure multiple thresholds is by paying for improvement, so that instead of thresholds there is a continuous scale across which performance and payments can be achieved. 
  • Multidimensional Output or Multitasking—Multitasking refers to situations in which the responsibilities of an individual encompass multiple activities or outputs that may require different types of skills to accomplish (Holmstrom and Milgrom, 1991). A hospital’s output includes many different components, such as managing a patient’s chronic illness, the timely and efficient diagnosis of a patient’s new symptom, transitioning patients from the hospital to outpatient care, and providing emotional support to patients and their families. Multitasking is relevant to P4P programs because the performance measures in these programs typically address only a narrow piece of a hospital’s outputs or the processes that contribute to outputs. It is hypothesized that if a large incentive is applied to one type of output, other outputs will be neglected, and overall care might worsen (Holmstrom and Milgrom, 1991).  Such concern is thought to explain why few private-sector corporations put large fractions of employee pay “at risk,” making them dependent on measures of output for which only a small fraction of what contributes to output can be measured (Asch and Warner, 1996).  A broader set of measures within a P4P program that includes process of care for a variety of clinical conditions, outcomes, patient experience, and efficiency could serve to mitigate this concern.
  • Intrinsic versus Extrinsic Motivation—Intrinsic motivation is a person’s inherent desire to do a task, while extrinsic motivation is the external incentive (such as P4P). Instead of supporting intrinsic motivation, extrinsic incentive “crowds out” intrinsic motivation, because when a task is tied to an extrinsic incentive, people infer that the task is difficult or unpleasant (Freedman, Cunningham, and Krismer, 1992). Increasing the size of the financial incentive is one way to address the crowding out of intrinsic motivation, though very large incentives run the risk of having the hospital overly focus on measured areas of care to the detriment of unmeasured areas of care. 

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